What Risks Keep REIT Executives Up at Night?

By Stuart Eisenberg, Partner, BDO USA: While U.S. REITs are enjoying healthy gains after a rocky start to 2016, industry executives are still contending with risks new and old.

Buoyed by a strong mix of economic fundamentals, U.S. REITs recovered in March from a slow start to 2016, outperforming the broader market and S&P index. While they continue to enjoy healthy gains, industry executives are contending with business risks both old and new, according to BDO’s 2016 report on REIT risk factors, an annual analysis of the risk factors cited in the most recent 10-K filings of the 100 largest publicly traded U.S. REITs.

The industry is watching warily as instability in the bond markets along with a turbulent stock market persists, which could lead to apprehension around credit and borrowing. Risks related to indebtedness are noted by 96 percent of REITs, up from 92 percent last year and 75 percent in 2014. And credit risk, including concerns around credit ratings and the ability to secure credit, is cited by 87 percent, up from 80 percent in 2015 and 55 percent the year before.

As they keep a close eye out for hints that the Federal Reserve might institute further interest rate hikes, REITs—considered high-yield investments—remain cautious of the potential impact such a move could have on their distributable cash flows and property values. REITs also worry that they may be unable to raise the capital needed to finance new assets and drive growth. Access to capital, financing and liquidity is consistently a top concern among REITs we analyzed, and remains so this year, highlighted by 96 percent.

Competition and industry consolidation are among their top concerns this year, cited unanimously among analyzed REITs. In some sectors crowded with smaller players, an uptick in M&A could be helping to restore balance. For instance, the single-family home sector is experiencing a wave of consolidation, including the deal between Starwood Waypoint Residential Trust and Colony American Homes that closed at the start of this year. Furthermore, fewer REITs this year (88 percent) mentioned inability to sell properties quickly in response to market shifts, reflecting a healthier seller’s market.

As foreign investment continues to grab attention and headlines, REITs worry the influx in crossborder capital could be squeezing the market. Foreign investors poured a record $91.1 billion into the market last year alone, more than twice what they purchased in 2014. Impediments to U.S. expansion and growth are highlighted by 63 percent of REITs–a figure that’s also more than double 2014 levels.

While Chinese investment makes up a relatively modest portion of the pie at 10 percent of all foreign direct investment in the U.S., it was recently reported that Chinese investment in U.S. real estate has eclipsed the $300 million mark. Foreign investors– and Chinese buyers in particular–will likely stay hungry for crossborder deals despite any wariness U.S. businesses might feel around regulatory hurdles, like filings with the Committee on Foreign Investment in the United States (CFIUS), tax complications or political consequences associated with selling to foreign investors.

As high-profile security breaches grow more commonplace across industries, REITs seem to be feeling the pressure to shore up their technology and protect their systems. Ninety-one percent of REITs cite security breaches as a risk, up 44 percent from 2014 levels. REITs could be especially susceptible to wire transfer fraud via phishing attacks. Roughly 156 million such emails are sent daily, and without any additional training or controls in place, they can be difficult to detect. Wire transfer scams can result in significant financial loss if a company falls victim and the transaction is not blocked. This could be contributing to the 96 percent of REITs that cited worries around uninsured liabilities.

REITs will need to maintain vigilance around interest rates, market turbulence, industry reshuffling and other emerging business threats. All this points to the increased importance of innovative and adaptive management strategies to address risks in a competitive and potentially volatile landscape.